Yield signal: India’s market for bonds has a mind of its own

Over the past month alone, this yield has risen by about 26 basis points, even though RBI’s rate-setting panel, the Monetary Policy Committee (MPC), has cut its key policy rate—the repo rate—by 100 basis points since February to 5.5%. 

The bond market seems to be marching to a different tune that shows little regard for robust growth data and RBI’s shift to an easier monetary regime under Governor Sanjay Malhotra. 

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The market’s behaviour may seem odd, but  it is not entirely surprising. The threat to economic growth, both global and domestic, from the ongoing trade turmoil and recent hike in new US tariffs to 50% in our case makes it harder for the Centre to meet its fiscal deficit target—set at 4.4% of GDP for 2025-26. 

The private sector’s reluctance to take the ‘baton’ on capital expenditure means the government will have to keep up its support for growth through public spending. The resultant pressure on central finances is already showing. The fiscal gap at the end of July was 30% of  the full year’s goal, with the trade shake-up’s impact yet to kick in.

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Economists may argue that the value of Indian exports to the US is insignificant, given the size of our $4 trillion economy, and hence bond market fears are overdone. 

The reality, however, is that the labour-intensive nature of the sectors most impacted by US tariffs means the government will have to grant them some fiscal support. 

Meanwhile, the expected move to rationalize the GST rate structure from four to two slabs is bound to lower its tax mop-up. Estimates of the revenue hit vary from a conservative ₹60,000 crore to a range of ₹1-2 trillion. Hence, chances are that the Centre will have to borrow more than it had planned. 

The G-Sec market’s yield curve—which plots yields across different maturity periods—has steepened in recent weeks, with yields rising more for long-dated securities than for shorter-dated G-Secs. This reflects weakened demand for the former (as lower bond prices mean higher yields) and suggests that investors expect the government to borrow more than its ₹14.82 trillion aim for the year. In short, it’s a warning signal.

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India’s central bank, as the Centre’s debt manager, may be tempted to groom the market to keep its borrowing costs lower than what today’s trend of hardening yields would imply. 

To that end, RBI could even resort to tactics like buying long-term bonds while simultaneously selling short-term securities. Dubbed ‘operation twist,’ this would reduce interest pressure at the long end of the yield curve. But there is a limit to how far RBI can push against market forces. 

At the cost of accepting ‘defeat’ should that curve refuse to flatten on its own, it would do well to recall the wry observation of a one-time White House advisor, James Carville: “I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody." This, it would seem, includes governments and central banks.